Financial engineering can have benefits for economies, but it has gotten out of control. As a result, it has created a fresh set of problems for the U.S. economy and others.

Many books that have covered the growth of financial engineering in the U.S. have expanded on so-called financialization.

The financialization of the economy refers to the substitution of financial activity for manufacturing growth and innovation.

The consequences of this substitution have been less business investment in capital expenditures and slower growth in labor productivity and in the overall economy.

Efforts to combat the slower economic growth have primarily been aimed at producing more financial engineering, but this additional financial engineering has exacerbated the situation resulting in even fewer capital expenditures, even slower growth of labor productivity and economic growth.

Changing this situation will require a change in the focus of economists and policymakers, time to implement new approaches to economic policy, and patience to allow the new direction to work.

Financialization in the U.S. began in earnest in the 1960s as Keynesian economic policies were introduced that attempted to fine-tune the American economy.

Through tax cuts and other fiscal policies, it was thought that the government could stimulate aggregate demand and economic downturns could be shortened, maybe even eliminated.

Once this philosophy gained ground within economic circles and the tax cuts during the presidential administration of John F. Kennedy became a reality, this idea of fine-tuning was expanded to apply to the whole economy in the hopes of producing even faster economic growth.

The statistical relationship called the Phillips Curve, a relationship between inflation and unemployment, was used to justify more fiscal stimulus, producing modestly more inflation, so that unemployment could be reduced to an even lower level.

Although in the late 1960s the economist Milton Friedman argued that this statistical relationship was valid for short-term purposes, it couldn't be maintained over time. The use of the Phillips Curve continued to be applied by policy markers even into the 21st century.

But the financial engineering of the economy started in the early 1960s produced the conditions late in that decade for the application of financial engineering to the banking industry. Commercial banks moved from just being asset managers to becoming liability managers to becoming asset-liability managers.

Commercial banks in the United States, historically had been limited in size due to the constraints upon geographic expansion. Their deposit bases were determined by how widely they could branch.

In the late 1960s, the larger banks in the U.S. discovered how the one-bank holding company could be used to expand their sources of funds. To manage their balance sheets, they created new financial innovations, the negotiable certificate of deposit and the Eurodollar deposit, in which funds could be purchased at the going market price.

That is these large banks could buy or sell funds in markets in the United States and Europe, at will, and expand or contract their balance sheets as they saw fit. Commercial banking has never been the same.

In the late 1960s into the 1970s, the government led financial engineering in the mortgage market as it assisted in the creation of the mortgage-backed security, an instrument that pooled mortgages into one big collection and then sold off the others various cash flows that were generated by the pool of mortgages.

The objective of this new innovation was to get mortgages off the balance sheets of commercial banks, mutual savings banks, and savings and loan associations so that they could grant even more mortgages and sell the new mortgage-backed bonds to pension funds and insurance companies that needed more longer-term assets for their balance sheets.

The gates were open. As the amount of credit was inflated in the economy and as price inflation became an economy-wide issue in the 1970s and 1980s, more financial innovations came forward. The junk bond was one such innovation. Financial derivatives were another. 

Advances in information technology contributed to this expansion of financialization because, at their most basic level, money and credit are nothing more than information, zeros and ones.

And, the politicians, both Republican and Democratic, continuing to seek re-election, produced more opportunities for more financial innovation.

An increasing number of financial institutions grew to support this expansion, and we got the growth of asset management firms, private firms, and hedge funds to take advantage of the opportunities that were available.

Even manufacturing firms got into the picture. Firms like General Electric, before the financial upheaval of the Great Recession, were so into financial engineering that more than 50% of their profits came from their financial divisions.

The government has only made the situation worse. My article, Bernanke is Underwriting the Wealthy, discussed how businesses and others with existing wealth were taking advantage of the government's economic policy and using the results of those policies to make lots of money.

Remember that John Maynard Keynes, the creator of Keynesian economics, was a wealthy trader who took advantage of the economic policies of government and has even been called by some as an early hedge fund trader.

More resources were directed into the financial industry and into the financial wings of corporate America. The office of the chief financial officer became one of the most productive profit centers in a business organization.

But, as the importance of the chief financial officer grew, the importance of the other engineers in the corporation declined. And, business innovation and investment declined as did the growth in the productivity of the labor force.

For the future health of the U.S. economy and the labor force, and the peace of those feeling excluded from the participation in the economic system, maybe economists and the government should refocus their efforts, more to the supply-side of the economy and to the impacts that advances in information technology are having on increasingly less-educated workers. Maybe there is some of this change already in the air.

This article is commentary by an independent contributor.